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Golden nuggets

Let me put you straight on one thing. Last week’s comments were assembled a week before publication and were not a knee-jerk reaction to the sell-off in markets in the middle of last week stimulated by the downgrading of sub-prime debt by the rating agencies. In face, the sell-off did not appear too damaging. One difficult day and a tail of unsettled drifting was all it amounted to.

That was last week. Heaven knows what has happened subsequently. Financial columns last week were full of the so-called sub-prime crisis and speculation on what a real credit crunch may have for the rest of us. The truth is that no one really knows. That there will be casualties is a given. The extent of any collateral damage is so far concealed from us.

A very interesting email distributed by one of the investment banks gives a particular insight into this aspect of the troubled credit scene. It is far from confined to debt markets. Instead it provides a brief and perceptive analysis on what the future drivers of opinion and action might be. Coming from someone in a hedge fund department, it covers some of the more esoteric aspects of investment.

I first came across this rather individual approach to what was going on in markets last December. From time to time, the nuggets this writer has unearthed have been recycled in some form or another in these columns. For his insight I remain truly thankful. Some of the chickens he has identified, so to speak, are now coming home to roost.

Practically the first issue of this, largely daily, personal view that came across my desk warned of the impending sub-prime crash but it appears from a more recent missive that the writer first drew attention to what was going on last September. Moreover, he pointed to the fact that the US housing market had actually peaked more than 12 months previously – in July 2005 to be precise.

He was gracious enough to declare that he had been wrong. Wrong, in the sense that he was too early. Indeed, had you followed his advice and shorted the lower end of the credit spectrum, which would have made money, you would have done far less well than by continuing to back riskier assets, like a number of smaller emerging markets. The appetite for risk remains far from assuaged and has hardly been deterred by recent events.

This, surely, is the real point. Will the pain suffered by investors faced with serious losses as a result of the near collapse in the sub-prime market mean a serious flight to quality? The answer is probably not, if the behaviour of markets since the debt rating agencies made their pronouncement is anything to go by. Unless, of course, the effect of even a modest credit crunch is felt in the wider economy.

This will all start in that great bastion of consumerism, the US. Not only are people being squeezed by falling house prices and dearer money – dearer than in the recent past, even if rates do lag those of the UK and Antipodean economies – but a declining dollar is adding inflationary pressures and lowering purchasing power.

The bulls would have you believe that the populous nations of the Far East are taking over the reins of the US consumer with sufficient alacrity to ensure a smooth transfer of power. I think not. Perhaps the future does lie in emerging economies such as China and India but anyone who believes a slower US economy will not affect the rest of us is living in cloud cuckoo land. Latent demand from the East may prevent the global economy from tipping over into recession but a slowdown is likely. Aside from anything else, China will welcome something of a pause. Inflation there is now becoming a concern.

Continue to play safe remains my advice – and also that of Bill Mott in his latest PSigma missive. Now there’s a manager with whom I feel in harmony in these uncertain days.

Brian Tora (brian.tora@centaur.co.uk) is principal of The Tora Partnership.

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